What are derivatives in finance?

What are derivatives in finance?

• A. Contracts linked to interest rates
• B. Financial contracts whose value depends on an underlying asset
• C. Equity shares of a corporation
• D. Long-term investment products

Answer: (B)

Derivatives are financial instruments whose value is derived from the price of an underlying asset. This asset can be anything from stocks and bonds to commodities and currencies. The defining characteristic of derivatives is that they are not standalone investments; rather, their value fluctuates based on changes in the price of the underlying asset. This relationship allows traders and investors to hedge risks or speculate on price movements. For instance, futures contracts, options, and swaps are all types of derivatives that serve various purposes in risk management and investment strategies. By using derivatives, market participants can gain exposure to the underlying asset without directly owning it, enabling strategies that can hedge existing positions or capitalize on market movements. The other choices do not encapsulate the essence of derivatives accurately, as they either refer to specific financial instruments or investment strategies that do not inherently involve the value dependency on an underlying asset as derivatives do.

Derivatives are financial instruments whose value is derived from the price of an underlying asset. This asset can be anything from stocks and bonds to commodities and currencies. The defining characteristic of derivatives is that they are not standalone investments; rather, their value fluctuates based on changes in the price of the underlying asset. This relationship allows traders and investors to hedge risks or speculate on price movements.

For instance, futures contracts, options, and swaps are all types of derivatives that serve various purposes in risk management and investment strategies. By using derivatives, market participants can gain exposure to the underlying asset without directly owning it, enabling strategies that can hedge existing positions or capitalize on market movements.

The other choices do not encapsulate the essence of derivatives accurately, as they either refer to specific financial instruments or investment strategies that do not inherently involve the value dependency on an underlying asset as derivatives do.